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Class 12 Economics Chapter 2 Determination of Income and Employment
Selected Questions & Answers
A. Very Short Answer Questions: (Marks for each – 1)
1. What is meant by aggregate demand?
Ans: Aggregate demand refers to the total demand for goods and servicesin an economy during a year.
2. If planned expenditure is greater than planned output, what will be the effect on the inventories of firms?
Ans: Inventories will decrease.
3. How is ex-ante aggregate demand determined at a given price level and fixed rate of interest?
Ans: Ex-ante aggregate demand is obtained by adding ex-ante total consumption expenditure and ex-ante total investment expenditure.
4. What are the maximum and minimum values of the investment multiplier? H. S. ’19
Ans: The maximum value is infinity and the minimum value is 1.
5. Define investment multiplier. H. S. ’19
Ans: The ratio of change in aggregate income to the change in investment is called the ‘investment multiplier.’
6. Given that the marginal propensity to save is 0.3, find the incomemultiplier.
Ans:
Income Multiplier (K) = 1 / MPS
= 1 / 0.3
= 3.33 (approximately)
7. What is meant by investment demand function?
Ans: The functional relationship between investment demand and the rate of interest is called the investment demand function.
8. What is consumption function?
Ans: The functional relationship between consumption and income is called the consumption function.
9. What is meant by full employment equilibrium?
Ans: Full employment equilibrium is a situation in which all available resources in the economy are fully employed.
10. How are equilibrium aggregate supply and aggregate demand determined?
Ans: Equilibrium aggregate supply and aggregate demand are determinedat the point where aggregate supply equals aggregate demand.
11. What is aggregate supply?
Ans: Aggregate supply refers to the total output available for sale in aneconomy during a year.
12. How is equilibrium income determined?
Ans: Equilibrium income is determined at the level where aggregatedemand equals aggregate supply, that is, where planned saving equals plannedinvestment.
13. Write True or False:
(a) In equilibrium, when the market for final goods is in balance, planned supply equals planned demand.
Ans: True.
(b) Consumption refers to what people actually spend in a givenyear, but it does not indicate what they plan to spend.
Ans: True.
14. Fill in the blanks:
(a) The situation in which people become more thrifty but total savings remain unchanged is called ———.
Ans: Paradox of thrift.
(b) The planned monetary value of a variable as opposed to it sactual value is called ———.
Ans: budgeted value
(c) The ratio of change in consumption to change in income is called———.
Ans: Marginal propensity to consume.
(d) A change in a graph due to change in an external factor is called——.
Ans: Shift of the curve.
B. Short Questions and Answers: (Marks for each – 2)
1. What is consumption expenditure?
Ans: In an economy, the total expenditure incurred by households on the purchase of goods and services for personal consumption purposes is called consumption expenditure.
2. Why is it said that only price changes occur in the long run?
Ans: The long run is a period in which both demand and supply can change. Supply can increase according to changes in demand, and changes in supply can also influence demand. Only in the long run can such full adjustmentstake place; therefore, it is said that variations are reflected through price and output adjustments over time.
3. What is marginal propensity to save?
Ans: Marginal propensity to save refers to the rate at which saving changesin response to a change in national income. It is the ratio of change in savingto change in income.
4. Explain the concept of consumption.
Ans: Every consumer spends a part of his income on consumption. Such expenditure is planned in advance. The remaining part of income is saved. Thus, the portion of total income that is spent on consumption after deducting saving is called planned or intended consumption.
5. If the marginal propensity to consume is 0.9, what is the income multiplier? H. S. ’15
Ans:
Multiplier (K) = 1 / (1 – MPC)
= 1 / (1 – 0.9)
= 1 / 0.1
= 10
6. Define excess demand in the context of income and employment determination. H. S. ’18
Ans: Excess demand is a situation in which aggregate demand exceed saggregate supply at a given price level. This leads to a rise in prices and may increase income and employment in the short run.
7. Distinguish between planned and actual investment. H. S. ’18
Ans: Planned (intended) investment refers to the investment that firms plan to undertake at different levels of income. It is a desired or expected amount. Actual investment refers to the real or realized amount of investment that actually takes place. Planned and actual investment may differ due tounplanned changes in inventories.
8. Explain any two fiscal measures to solve the problem of excess demand in an economy. H. S. ’19
Ans: To solve the problem of excess demand, the following fiscal measures may be adopted:
(a) The government can reduce its expenditure on public works such as roads, electricity and irrigation, thereby reducing aggregate demand.
(b) The government can increase taxes, which reduces disposable in comeand lowers consumption demand.
9. In an economy, MPC is 0.4. How much new investment is required to generate an additional income of ?500 crore? H. S. ’19
Ans:
Multiplier (K) = 1 / (1 – MPC)
= 1 / (1 – 0.4)
= 1 / 0.6
= 1.67 (approximately)
Required Investment (?I) = ?Y / K
= 500 / 1.67
300 crore (approximately).
10. Distinguish between autonomous investment and induced investment. H. S. ’16
Ans: Autonomous investment is investment that does not depend on the level of income. It is generally undertaken by the government and is influenced by factors such as public welfare schemes, population growth andinfrastructure needs. The autonomous investment curve is horizontal. Induced investment is investment that is influenced by changes in income, output,
sales and profits. It is generally undertaken by the private sector. As national income increases, induced investment increases; therefore, the induced investment curve slopes upward.
C. Medium Answer Type Questions: (Marks for each – 4)
1. What are the determinants of investment demand? Explain.
Ans: There are several determinants that make investment demand effective. Two of them are explained below:
(a) Cost of investment: Capital is required for any investment. The capital necessary for productive activities is collected from various sources. Especially, funds are borrowed in the form of loans. Interest has to be paid on such loans. This interest is included in the cost of investment.
(b) Business expectations: Before making investment, production firms form expectations about the future. The future is uncertain. Therefore, investment demand also depends on the entrepreneur’s expectations about what may happen in the future. An investment becomes profitable only whenthe expected annual net return is positive. Generally, entrepreneurs invest only in profitable projects. Again, when the rate of interest increases, the annual net return decreases.
2. Explain the concept of ex-ante investment.
Ans: Ex-ante investment refers to the amount of investment that production firms and economic planners intend or plan to undertake at the beginning of a particular period. In contrast, ex-post or actual investment is the investment measured at the end of a specified period. For example, suppose a person or abusiness firm plans at the beginning of the year to increase the stock of goods by 100 units by the end of the year. In this case, the planned or ex-ante investment for the year will be 100 units. But if, due to an unexpected increase in demand in the market, the firm sells 20 units more than planned, then at the end of the year the stock of goods will be (100 – 20 = 80) units. Here, the planned investment of the producer is 100 units, while the ex-post investment
will be 80 units.
D. Essay-type Questions: (Marks for each – 6)
1. What are the components of aggregate demand? Briefly explain.
Ans: Demand refers to the desire or need for a commodity. Aggregate demand has several components, such as:
(a) Private consumption demand: Private consumption demand refers to the value of goods and services on which the household sector expresses its purchasing power and willingness to buy.
(b) Private investment demand: Expenditure incurred in a planned manneron machinery, buildings, raw materials, etc., used in private enterprises is called private investment demand. It is a systematically organized activity. It is of two types: autonomous investment and induced investment.
(c) Government demand for goods and services: The planned expenditure of the government on consumption and capital goods for fulfilling the common needs of society is called government demand for goods and services. It includes expenditure on public services such as schools, transport systems, hospitals, roads, etc.
(d) Net export demand: The excess of a country’s exports of goods and services over its imports is called net export demand. It depends on the foreign exchange rate, trade policy, and the balance of payments position. In brief, net export demand = exports – imports.
